Chapter 31: Is Your Comp Time Immediately Taxable?

Compensatory time off or “comp time” is paid time off taken in lieu of pay. In the case of State and local governments, the Fair Labor Standards Act (FLSA) allows them to provide non‑exempt workers with comp time in lieu of overtime. State and local governments may also provide their exempt workers with comp time in lieu of regular pay. Continue reading

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Chapter 30: Some “Elections” Do Work

Previously, I’ve written about the pitfalls of giving employees “too much choice” with respect to their pay, their paid time off and other benefits.  Employee elections that are not properly designed can unexpectedly result in current taxation under either the “constructive receipt doctrine” or the “assignment of income doctrine.” Continue reading

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Chapter 29: The “Misunderstood” Group Variable Annuity Contract

Group variable annuity contracts are often used to wrap mutual funds to provide greater revenue to plan providers or to provide access to an insurance company’s stable value fund. Every public agency 457(b) plan or 401(a) plan that offers a stable value investment option includes a group variable annuity contract.

Some contracts contain significant “surrender” charges or “back-end loads.” Oftentimes these charges continually renew as new money comes in. Some contracts restrict participant and/or sponsor access to the funds in the event of a contract termination. In many cases, the contract issuer can require a full year’s notice and continuation of the contract before the contract can be surrendered. Because the stable value fund feature of many such contracts guarantees or credits interest at higher than short term interest rates, some contracts contain a “mark-to-market” feature that allows the issuer to pay over the adjusted market value of the fund (a lower amount) rather than the so-called book value – the amount shown on participant statements. All of these fees, restrictions and adjustments can cause significant problems or issues for plan sponsors who wish to leave an insurance company plan provider for another provider. For these reasons, it is important for plan sponsors and plan committees to know whether their plans are subject to such a contract and what the contract says.

Often a prospective record keeper or investment provider will offer to pay and “finance” any surrender charges or back-end loads that may be incurred by reason of a record keeper transition. Special care must be given to these types of arrangements because the Internal Revenue Service has issued guidance indicating that such payments will generally be treated as additional employer contributions. Unless certain precautions are taken, most plan documents would require that any such payments be allocated to participants based on relative compensation – not based on the actual surrender charges assessed to them.

Because group annuity contracts are generally regulated by State insurance law, the issuers may have less flexibility to modify or change the terms of a contract. That is why it is important for plan sponsors and plan fiduciaries to fully understand the terms of their group annuity contracts. Don’t wait to review your contract until after you have sent a notice of termination to your current provider.

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Chapter 28: Why Cashing Out PTO Next Year Doesn’t Work

Our efforts to educate employers about the dangers and surprises associated with PTO cash‑outs (see, Chapter 13 and “When Having Your Cake and Eating It May Be a Bad Thing: Cautions About Cash-Outs of Unused Leave Or PTO”) are having an effect. Unfortunately, some of the changes and adaptations to MOUs regarding PTO cash-outs simply do not go far enough.

One of the newer “variations” that we have come across gives employees that have already accrued a certain amount of PTO the right to make an irrevocable election in calendar year 1 to receive a cash-out of a portion of their already accrued PTO as of the beginning of calendar year 2. For example, an employee who has already accrued 120 hours of PTO has the right prior to the end of this year to elect to receive a cash-out of up to 60 of those hours, which will not be paid until the beginning of next year.

Presumably the “thinking” behind this variation is that the employee must make an irrevocable election to receive additional compensation (or not to receive it) in the year prior to the year of actual receipt – and that this timing rule somehow avoids application of the “constructive receipt” doctrine. In our view, it doesn’t.

The reason it doesn’t work to prevent the employees who have the election from being taxable in   year 2 is because the employees have already accrued or earned the PTO that is being cashed out. The consequence is that the employees are being given the absolute right to decide this year whether they will receive additional cash early next year. Yes, the fact that they cannot receive the cash-out this year will prevent the money from being taxed this year, but it will not keep the amount subject to the election from being taxable in year 2. Therefore, all employees who are given the election will have additional taxable income in year 2 even though they do not elect to cash out anything.

So, what’s still missing? In order for the above scenario to turn out correctly, the irrevocable election in calendar year 1 to cash out PTO must be made with respect to PTO that has not yet been earned and which will be earned in calendar year 2 or years into the future. Because the employee does not know whether he or she will earn a specific amount of PTO as of the beginning of year 2, the policy will have to be adapted to account for rates of accrual and the chance that the employee may leave early or not earn the PTO he or she elected to cash out.

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Chapter 27: Do You Have a Proper Cafeteria Plan?

The recent Ninth Circuit decision in Flores v. City of San Gabriel focused on the circumstances under which the value of certain non-cash-wage benefits (such as those provided under “cash-in-lieu” programs or cafeteria plans) must be included in the determination of FLSA overtime wages. We thought that many public agencies would be asking us about whether their cafeteria plans met the “bona fide plan” exception mentioned in the case. However, we were surprised to learn that quite a large number of public agencies still do not have a proper cafeteria plan document even though they maintain “cash-in-lieu” arrangements or benefit programs that operate as nontaxable cafeteria plans. In order to avoid the risk that the IRS might take the position that your cafeteria plan does not have the required “written plan” and that, as a result, your employees are taxable on the amounts that they could have received as wages (even if they selected nontaxable benefits), you should have a cafeteria plan document that satisfies the following requirements:

  1. A specific description of each of the benefits available through the plan;
  2. Rules on participation and requiring that all participants be employees;
  3. Procedures governing employees’ elections under the plan, including the period when elections may be made, the periods with respect to which elections are effective, and providing that elections are irrevocable, except to the extent that the optional change in status rules are included in the cafeteria plan;
  4. How employer contributions may be made under the plan;
  5. The maximum amount of employer contributions available to any employee through the plan, by stating the maximum amount of elective contributions available to any employee through the plan, expressed as a maximum dollar amount or a maximum percentage of compensation or the method for determining the maximum dollar amount;
  6. The plan year;
  7. If the plan offers paid time off, the required ordering rule for the use of nonelective and elective paid time off;
  8. If the plan includes flexible spending arrangements (FSAs), the plan’s provisions complying with any additional requirements for those FSAs;
  9. If the plan includes a grace period, the plan’s provisions complying with the grace period requirements; and
  10. If the plan includes distributions from a health FSA to employees’ HSAs, the plan’s provisions complying with the applicable requirements.
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